The
Profitability gauge is determined by calculating a score for each of
the four quantities listed above. A weighted average of the scores is
scaled to set its minimum value at zero and its maximum value at 25
points.

We're tough graders: it's rare for a company to achieve a 25-point Profitability score.

The
scoring details are described below. Please note there is an
overriding zero-point floor and a five-point ceiling for each ratio.

Recall that the Accrual Ratio is proportional to the difference between Net Income and CFO.
A negative Accrual Ratio indicates that CFO exceeds Net Income, which
is suggestive of high-quality, operations-driven earnings.

Our
score for the Accrual Ratio has two components: the first is
proportional to the ratio's value, and the second is proportional to the
ratio's change from the previous year.

The first component of this score, worth 2.5 points, is determined by the following equation:

Score = 0, if the Accrual Ratio is positive

= (-50) * Accrual Ratio, if the Accrual Ratio is negative.

The 2.5-point cap is hit when the Accrual Ratio is -5.0 percent or lower.

The second component of this score, worth another 2.5 points, is determined by this equation:

Score = 0, if the Accrual Ratio is higher than it was one year ago

=50 * (decrease in Accrual Ratio), if the Accrual Ratio has dropped

If the Accrual Ratio dropped from -0.5 percent to -1.2 percent, the score would be:

(-50)*(-0.012) + (50)*(0.007) = 0.95 points.

Determining the Profitability Score

We use the following weights for the different Profitability score components.

Disclosure

This blog describes and gives examples of a particular quantitative methodology, relying on published financial statements, to analyze businesses. The methodology does not evaluate every aspect of a company's finances or operations. Other analytical techniques may be better suited to some evaluations, depending on the type of business or the goals of the analysis. The material in the blog is not investment advice, nor does it constitute an offer or solicitation to buy or sell any security. The author might have, might once have had, or might be considering a position in the companies mentioned. Specific positions will not be disclosed. While good-faith efforts are made to use reliable information sources and to provide accurate analytical results, accuracy is not guaranteed. All results are subject to change without notification. Application of the analytical methodology described in this blog requires that various assumptions be made. The assumptions are generally not disclosed and are subject to error, invalidating some or all of the analysis results. In looking for trends, recent financial data is compared to historical financial data; however, underlying differences in the assumptions or presentation of the data might degrade or invalidate these comparisons and could produce erroneous or misleading results. Readers should independently validate any information in this blog that causes them to consider making or not making a financial transaction.